Equities
: Even as more and more Wall and Bay Street strategists wave cautionary flags about the near‐term prospects for equities, the most common question the PAG Equity desk receives these days is “My client’s cash weighting is too high… what stocks would you be buying right now?” Strong YTD performance and a lack of investment alternatives continue to drive funds flows toward the equity market, the U.S. in particular. We’re seeing “frothy”, “bubble”, and “overvalued” more frequently in the media nowadays, but these are not adjectives we would ascribe to equity markets because all of these imply that a sharp correction is in the offing.
Equity markets may indeed be overdue for a pause, but with the outlook for global growth improving, tail risk declining, and headwinds facing most other asset classes (such as fixed income and commodities), we expect any pullback to be modest and relatively short
‐lived. Capital markets will remain focused on Fed tapering, with November’s employment report (due Dec. 6) being a critical piece to the tapering timetable. Investors with
short investment horizons should consider selective profit‐taking with an aim of reinvesting after a modest pullback.
Regionally, we continue to view the risk ‐reward proposition offered by European equities as
Regionally, we continue to view the risk ‐reward proposition offered by European equities as
attractive. To our U.S. neighbours, we wish you a happy Thanksgiving and we give thanks for a spectacular performance YTD! Looking ahead to 2014, we aren’t expecting an encore performance… U.S. equity returns will likely come solely from earnings growth (consensus forecast calling for 11% YoY earnings growth for S&P500 next year).
Fixed income: We continue to see merit in our broader macro view, namely that bond yields will likely rise but that the pace will likely be more steady and incremental, with smaller bouts of data dependent volatility. Our view is predicated on (1) that the Fed is now likely to have greater continuity with the general tone of a Bernanke led Fed as Janet Yellen’s confirmation was referred to the Senate, (2) any asset paring will likely be met with other accommodative action, whether that be a change in forward guidance or other market operations, (3) broader macro growth although tepid, seems likely poised to gain some traction in 2014, and (4)
the more recently dovish BoC tone will continue to figure prominently in market sentiment. Although key risks remain, particularly in relation to U.S. political developments, bond yields seem increasingly likely to remain range bound but with a modest upward bias in the near term. As well, the front end of both US and Canadiancurves have been demonstrating more buoyancy which we believe will continue for the foreseeable future.
Preferreds: The preferred share market has found its groove as it has started to trade in a sideways fashion. With two rate reset redemptions occurring Dec 31, 2013 (GWO.PR.J and IAG.PR.C), the search for reinvestment ideas continues as investors flock to the good quality (Pfd ‐2L and above) rate resets with attractive spreads as well as bank perpetuals, which is keeping the market well bid. We are anticipating that this trend will continue as we get through tax loss selling and into 2014 when there should be further redemptions in the rate reset space.
Capital Markets
: Is quantitative easing the next step for the ECB; How about them banks, eh?
After unexpectedly cutting interest rates to 0.25% on Nov 7, economist Nouriel Roubini (a.k.a. Dr. Doom, famous for predicting the U.S. housing collapse and ensuing worldwide recession) recently suggested that the European Central Bank will soon resort to quantitative easing as Europe flirts with deflationary risks. Combined with an inflection in some economic data, the potential for quantitative easing further supports our interest in European equities.
Strong share price performance by the Canadian banks is threatening to overtake hockey as the most popular armchair sport in Canada. Driven by increasing comfort in a soft landing scenario for housing, forward P/E for the bank group has expanded by 1.8 multiple points since June to 11.5x. Under normal conditions, Cdn banks have traded in the 12x ‐13x range. All you kids out there, stay tuned for Earnings week in Canada that kicks off next week; current consensus is pointing to 9.8% YoY earnings growth for the group.
Bank of America is the latest to forecast further downside risk to gold in 2014. BofA sees gold hitting US$1100/oz next year as the Fed begins to taper and the U.S. dollar appreciates. BofA expects oil, copper, and natural gas to remain range bound. UBS cut its one ‐ and three‐month gold price forecast to US$1180/oz and US$1100/oz, respectively.
Economics
: Recent data supports early‐2014 Fed tapering; Canadian economy moderating
Recent U.S. housing and employment data continue to point to possible Fed tapering decision in January or March 2014. While November’s jobs report (due Dec 6) will be the most important data point between now and the next Fed meeting (Dec 18), weekly initial jobless claims have shown promising trends in recent weeks (4‐week avg declined to 332k vs. 358k at the end of Oct).
U.S. Housing data has been mixed, with October existing home sales continuing to slide (5.12M vs. 5.14M est 5.29M in Sep) and the mood of U.S. homebuilders remains below the peak in August. Average home prices, measured by S&P/Case Shiller, continue to show strong uptrend (Sep +13.3% YoY vs. +13% est). October’s building permits, which tend to foreshadow housing starts, reached a five ‐year high (1034k vs. 930k est). There are two ways to interpret this strong reading: there is pent up housing demand from ongoing employment
gains, or that the drop in mortgage rates after the September FOMC meeting spurred activity. Unfortunately, the most important housing data, housing starts, has been delayed until Dec 18 due to the Oct government shutdown. In our opinion, the U.S. consumers’ ability to cope with higher mortgage rates is critical to the tapering equation.
Canadian data showed moderating consumer trends, with Sep home prices gains slowing (+1.6% YoY vs. +1.7% est and +1.8% in Aug), decelerating Sep ex ‐auto retail sales (0% MoM vs. +0.2% est and +0.5% in Aug), and Oct headline inflation slowing further (+0.7% YoY vs. +0.8% est and +1.1% in Sep). Weaker data has contributed to a 1.5% drop in the C$ so far this month. We expect headwinds for the C$ will likely extend into 2014.
Geopolitical
: Tentative breakthrough with Iran; China trickling out reforms
Western nations reached a six‐month interim agreement with Iran regarding the latter’s nuclear program. Under the terms of the agreement, Iran has committed to stop enriching uranium beyond 5% and grant access to inspectors. In return, no new nuclear ‐related sanctions will be imposed on Iran for six months and Iran will receive up to $7B of relief on existing sanctions. Should Iran live up to its commitments under this confidencebuilding first step, further relaxation of sanctions are likely, including a possible loosening of oil export restrictions. After an initial knee ‐jerk reaction, Brent crude oil prices have recovered as traders take a wait‐andsee
approach.
China has started to trickle out reform decisions reached at its recent planning session. While precise details have yet to be disclosed, easing of the controversial one‐child policy, dismantling of some state‐owned entities, removal of roadblocks for capital raising, and liberalizing the financial system’s ability to set interest rates are among the reforms announced to date.(Portfolio Advisory Group - 2013 Year End - Here's What We're Thinking - Forum) - E
